Basic Accrual Concepts

Accrual vs. Cash

Accrual accounting - and budgeting - matches income and related expenses in the same fiscal period, regardless of the timing of the receipt or disbursement of actual cash. Many small and midsize nonprofit organizations operate on a modified accrual basis - that is, mostly on a cash basis except for year-end adjustments for accrual.

Six basic Accrual concepts:

Prepaid Expenses [Asset]

Things that your organization has bought for future use, such as merchandise inventories, supplies, or brochures for next season.

Payments your organization has made for goods or services that have not yet been received or used, such as insurance premiums that could be refunded to you if cancelled the policy, or expenses relating to future fiscal years paid in advance, such as a deposit for next year's industry conference.

Cash is disbursed before it is the appropriate time to record an expense. The prepaid asset is converted to an expense at the appropriate time via an adjusting journal entry, reducing the prepaid asset and increasing the expense. The timing of this conversion to expense must be taken into account when constructing the operating budget.

Receivables [Asset]

Grant awards (documented, unconditional promises to give) and payments that are due for program services already rendered are recorded as income (whether deferred or current) at the time they are promised or earned, even though the cash has not yet been received.

The receivable asset is converted to a cash asset when the check arrives and is deposited in the organization's bank account. Receiving the payment increases cash and decreases the receivable. Income is not affected as it was already recorded when the invoice (receivable) was entered.

Fixed Assets / Depreciation [Asset / Expense]

Purchases should be capitalized (treated as assets rather than outright expenses) if the item(s) will have a useful life of more than one year and cost an amount higher than an established threshold amount. For small and midsized groups the threshold amount is usually set at $750 or $1,000.

A fixed asset is acquired at cost, but is depreciated (the cost is spread) over the useful life of the asset. The asset is converted to an expense via journal entry increasing expense (depreciation) and decreasing the value of the fixed asset (accumulated depreciation).

Maintaining a depreciation schedule (sometimes called a fixed asset schedule) helps an organization predict the depreciation expense. Amounts from the schedule are used when constructing the operating budget.

Payables [Liability]

Vendor payables and employer payroll tax liabilities are recorded as expenses (whether prepaid or current) at the time they become owed, even though not yet paid.

These liabilities are converted to cash disbursements when the bills are paid. That is, cash is reduced and the liability is reduced simultaneously by paying the bill. The expense is not affected as it was already recorded when the bill (liability) was entered.

Accrued expenses are usually estimates rather than actual bills, for instance: accrued vacation pay or accrued interest. These liabilities are recorded via journal entry, increasing expenses and increasing liabilities simultaneously. The timing of this must be taken into account when constructing the operating budget. Adjustments to the accrued expense balance(s) should be made as appropriate but at least annually.

Deferred Revenue [Liability]

Deferred revenue, which usually pertains to earned revenue, is a payment to your organization in advance for services that have not yet been delivered and that your organization would be liable to refund if the service is not delivered. Examples: tuition received for future classes, payments for full season subscription tickets for next fiscal year, advances for agency contracted services.

The liability is converted to income via journal entry at the time the organization delivers the service and becomes entitled to the income, reducing the liability and increasing income. The timing of this must be taken into account when constructing the operating budget.

Contributions that are restricted by the donor for a particular purpose or future time period must be accounted for separately from unrestricted.

When the restriction has been satisfied, restricted funds are "released from restriction" and converted to unrestricted income via a journal entry, reducing restricted revenue and increasing unrestricted revenue.

A time restriction is satisfied when the future time period is reached and the promised grant money is in hand.

A purpose restriction is satisfied when expenses are incurred to fulfill the restricted purpose; at that point the restricted funds are released to pay for the purpose-related expenses.

Restricted amounts carried over for release in a future fiscal year must be taken into account when constructing a budget.

Operating budgets done on an accrual basis can be used as a source for cash flow projections, but must be adjusted for changes in non-budget balance sheet accounts and cash requirements, such as the status of receivables and payables and payments of principal on loan balances, and for non-cash items such as depreciation.